Spin-Offs: Biotech's Growth Hormone

Drugmakers are selling assets, and venture funds are buying

The venture-capital firm Warburg Pincus International sank $59 million into a new biotechnology firm called ProSkelia last year. That's a pretty big bet to make on a startup in an industry that produces many more losers than winners. But Warburg isn't worried: ProSkelia, which specializes in bone-disease research, isn't really a startup in the traditional sense. It used to be a fully staffed division of the giant Franco-German drugmaker Aventis.

ProSkelia is one of a growing breed of European biotech firms -- new companies that are actually spin-offs from global drugmakers. Unlike the slew of European biotechs started in the past few years with little more than a good idea and a few scientists, these companies are fully operational from inception -- with experienced management, state-of-the-art labs, and drugs in the clinic.

And venture capitalists, badly burned by the collapse of biotech stock prices in the past two years, are lining up to fund them. "With the drug industry under intense earnings pressure, there will be an increasing number of these spin-offs," says Nicholas J. Lowcock, a managing director at Warburg Pincus. About a dozen such companies have been created in Europe in the past five years.

Why is Big Pharma dumping these sometimes promising businesses? After the recent spate of megamergers, European companies are under pressure from shareholders to divest noncore or overlapping assets. In addition, companies are refocusing their research and development on therapeutic areas with blockbuster sales potential. As a result, promising yet less lucrative research projects are being shelved. The frustrated scientists behind these projects are persuading management to sell the assets to venture funds, often keeping a minority stake for themselves.

The cast-off biotechs offer rich pickings for a venture capital industry awash with billions of dollars. MPM Capital LP, a venture-capital outfit with offices in Boston, San Francisco, and Munich, recently closed a $900 million biotech fund, the largest ever raised. For large funds such as MPM, the spin-offs offer a less risky way to put large amounts of cash to work. Indeed, the bulk of the $1.3 billion in venture capital invested in European biotech last year went to more mature companies. "With spin-offs, investors can make an average of three to five times the money invested," says Michael Steinmetz, general partner at MPM Capital. That's a lot less than the twentyfold multiples that can sometimes be earned in pure startups, he says, but it's also a lot more sure. Only 60% of traditional startups even earn investors their money back, while 90% of the spin-offs do.

Steinmetz is behind some of the most successful spin-offs to date. When Swiss drugmaker Roche Group began restructuring its R&D to focus on a few core therapeutic areas, Francesco Sinigaglia, head of Roche's inflammatory disease research center in Milan, contacted his friend Steinmetz, who had headed Roche's U.S. drug discovery business before joining MPM. Together they approached Roche CEO Franz B. Humer. BioXell was spun off a year later, with $22 million invested by MPM and two other venture firms. Roche kept a 17% stake. BioXell now has seven promising drugs under development. Steinmetz was also involved in Pharmacia Corp.'s (PHA ) spin-off of its Stockholm-based metabolic disease center, now an independent firm called Biovitrum, in which Pharmacia retains a 19% stake.

The next stage for these not-so-new startups: public stock offerings. If successful, this new breed of biotechnology company will breathe life into an ailing industry and provide some badly needed credibility with long-suffering retail investors.

By Kerry Capell in London

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